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Japan investment opportunities – what next?

Nov 23, 2014

In January we published a post on the Japanese stock.

The bold initiatives taken by Mr. Abe, the so called “Abenomics”, the QE measures which has the objective of targeting 2% annual inflation rate is aimed at reviving Japanese fortunes and wake it from the slumber of the last 25 years. To a reasonable degree it is working, helped now also by lower fuel prices and will be helped further as Japan restarts its nuclear energy generation.

The Yen has weakened from 87 to close to 120. The stock market is up by a similar percentage.  But what is next? Will the Yen continue to weaken? Will the stock market continue to rise? Will consumers start spending? Will companies invest?

In the new paradigm every central bank is implementing the same policies, because QE and extra QE, through the asset buying programme, has worked in the United States. A lot of jobs have been created, the dollar is appreciating and US balance sheet is becoming stronger. In the US, the energy revolution is an additional significant boost to the economy.

Weaker currencies can cause havoc for the lower income citizens in countries that are large importers. It is also a danger for the economy. Because prices rise, consumption falls. This is what appears to be happening in recent weeks in Japan. Stock markets are up, currency is down, but GDP is down. Growth in Europe is similarly showing weaker trend, even though property prices and stocks markets are up and the Euro is weaker.

Some say that the real problem for the world is that wealth is being created at the top and is not efficiently trickling down. But it is harder for Central Banks and governments to build bottom up. QE does causes nominal wealth to rise because of asset price inflation. However in the short term the vast majority who own very little of national income and assets don’t benefit from QE. Price rise of an average home may make the owner feel good but it cannot easily be pumped into the economy.  That takes time. Those at the top cannot consume more, but that even bigger cash pile also does get used up one way or another, through asset purchases or lending. Rising stock markets are usually followed by more investment by business. Ultimately, QE does feed through.

Japan has structural problems with demographics, lack of immigration, a divided political system and some argue waning influence by its industrial giants. In our view, this is largely because of poor growth over many years. There appears to be lack of innovation, some say. Well, innovation stalls in a weak economy. Innovation doesn’t come without spending money.

What will wake up Japan?

We believe that the injection of stimulus is the right course of action. The Yen could weaken further to perhaps 140 or even 150 to the dollar. The Nikkei is then likely to rise, in our view, to 30,000 over the next 2-3 years.

Japan needs to accelerate its investments overseas. Not just in the stock markets, as has been announced, but in factories and infrastructure. Perhaps the best way for Japan to import inflation is through foreign investment, preferably in the emerging markets.

Japan will wake up. And as it does, Japan will invest more. The Japanese people are highly educated and hard working. Given the right economic conditions Japan can compete and even lead. On the other hand the down side risks, if Abenomics doesn’t work, will be catastrophic for Japan and the rest of the world.

What this means is that Japan is once again a potential land of opportunities for foreign investors.  However, just because Japanese equities are on a roll, one must not assume that there are no risks. When investing in foreign assets managing the currency exposures is key to better outcomes.  In Japan  the 2% inflation target will, sooner or later, lead to higher bond yields for JGBs and widening credit spreads. Japanese equities should continue to rise well after the currency has bottomed. Currency volatility is likely to increase.

The right sectors or companies to be invested in and for how long will key to success.

We are not making any recommendation to buy or sell any investment in Japan or anywhere else. Any view expressed may turn out to be wrong. Algoam usually doesn’t have views on markets. We develop 100% systematic investment strategies. We believe that risks have to be monitored, measured and acted up continuously.

Algoam can help you manage the risks of investing in Japan. We have systematic methods on the Japanese market and to identify Japanese stock portfolios. All of our strategies have risk management overlays.

Please contact us for more information.